Is a former Merrill Lynch employee's reinstated restricted stock and stock option income, given in exchange for signing a noncompetition agreement, taxable by New York once he becomes a nonresident?

Plain-English summary

The Petitioner worked for Merrill Lynch in its New York City office while a resident of Connecticut, until he resigned effective March 31, 2005. In February 2004 and February 2005 he had received nonqualified restricted shares and stock option units (RSUs) tied to his prior year's performance, but the RSU agreements said that any unvested RSUs would expire and be forfeited 30 days after an employee's termination - unless the termination was treated as a "reduction in staff."

After Petitioner submitted his resignation, Merrill Lynch asked him to keep working until March 31, 2005, help transition his clients, and sign a three-year noncompetition agreement barring him from working at another recognized investment bank. In exchange for signing and complying with that agreement, Merrill Lynch reinstated his otherwise-forfeited RSUs by recharacterizing his departure as a reduction in staff, which let the RSUs vest. The noncompetition agreement itself said nothing about paying Petitioner for his other post-resignation work; he kept receiving his regular salary for that, which he reported on his 2005 New York nonresident return.

The question presented was whether the stock-based income Petitioner realized in 2006 and 2007, once he was a nonresident, was subject to New York income tax. The Department concluded it was not. A nonresident is taxed by New York only on income derived from or connected with New York sources - income attributable to a business, trade, profession, or occupation carried on in New York, or income from intangible property employed in a New York business (Tax Law § 631(a), § 631(b)(1)(B), § 631(b)(2)). Had Petitioner remained employed, or had his resignation not triggered forfeiture under the RSU agreement, the RSUs would have been New York-source income when they vested or were exercised. But here the RSUs were reinstated purely as consideration for signing the noncompetition agreement, not for services performed in New York.

Relying on Matter of Colitti (Tax Appeals Tribunal, June 19, 2003), the Department reasoned that a nonresident can only earn payment under a noncompete by refraining from performing services anywhere, including New York - so taxing that payment as though it were New York business income would tax him for services he specifically did not perform. Because the reinstated RSUs did not fit either category of New York-source income under Tax Law § 631(b)(1)(B) or § 631(b)(2), the Department ruled Petitioner's 2006 and 2007 stock-based income from the reinstated RSUs was not subject to New York income tax.

What this means for you

Nonresidents who sign a noncompetition agreement with a former New York employer

If equity awards or other compensation are given specifically as consideration for signing a noncompete - and not as pay for services you actually perform - that income generally isn't New York source income once you're a nonresident, even if the underlying awards were originally earned while you worked in New York. The key is whether the payment compensates you for the covenant not to compete, versus compensating you for work carried on in New York.

Employers and equity plan administrators reinstating forfeited awards

When forfeited RSUs or options are reinstated as the price of a departing employee's noncompete - rather than as deferred pay for prior New York services - documenting that the reinstatement is consideration for the covenant (as this noncompetition agreement did, separately from Petitioner's continued salary for transition work) supports treating the income as outside New York's taxing reach for a nonresident.

Accountants and tax professionals

Separate any regular salary paid for actual post-resignation services (which remains New York-source to the extent the services were performed in New York, as Petitioner's was on his 2005 nonresident return) from equity or other amounts paid solely in exchange for a noncompetition covenant. Only the latter falls outside Tax Law § 631(b)(1)(B) and § 631(b)(2) under this reasoning.

Common questions

Q: Why weren't the reinstated RSUs treated as pay for Petitioner's New York work at Merrill Lynch?
A: Because the RSUs had already been forfeited under the RSU agreement once Petitioner resigned; they were reinstated only as consideration for signing the three-year noncompetition agreement, not as pay for services performed in New York.

Q: Would the outcome have been different if Petitioner had stayed employed by Merrill Lynch?
A: Yes. The Department noted that had Petitioner remained employed, or had his resignation not caused forfeiture under the RSU agreement, the RSUs would have been New York-source income taxable when they vested or were exercised.

Q: What was Matter of Colitti and why did it matter here?
A: In Matter of Colitti (Tax Appeals Tribunal, June 19, 2003), the Tribunal held that a nonresident's payment for signing a noncompetition agreement was ordinary income but was not attributable to a New York business, trade, profession, or occupation, because the taxpayer could only earn it by refraining from performing services anywhere, including New York. The Department applied that same reasoning to Petitioner's reinstated RSUs.

Q: Was any of Petitioner's post-resignation income taxable by New York?
A: The ruling addresses only the reinstated RSUs and stock option units. Petitioner's regular salary for his post-resignation transition work was separate compensation that he reported on his 2005 New York nonresident return.

Q: Does this ruling mean all equity compensation to a nonresident escapes New York tax?
A: No - it turns on the reinstated RSUs being consideration specifically for the noncompetition covenant. Equity or other compensation tied to services actually performed in New York remains New York-source income under Tax Law § 631(b)(1)(B).

Citations and references

• Tax Law § 631(a) - defines the New York source income of a nonresident individual
• Tax Law § 631(b)(1)(B) - New York source income includes items attributable to a business, trade, profession, or occupation carried on in New York
• Tax Law § 631(b)(2) - New York source income includes income from intangible personal property employed in a New York business, trade, profession, or occupation
• Matter of Colitti (Tax Appeals Tribunal, June 19, 2003) - a nonresident's payment for signing a noncompetition agreement is ordinary income but is not attributable to a business, trade, profession, or occupation carried on in New York

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2009.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a09_2i.pdf

Original ruling text

New York State Department of Taxation and Finance

Office of Counsel
Advisory Opinion Unit

TSB-A-09(2)I
Income Tax
February 9, 2009

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I080930B

The petition asks whether the 2006 and 2007 stock-based income of Name redacted (Petitioner) was earned
by him pursuant to a non-competition agreement while a resident of Alabama and, as such, is not subject to
New York income tax.
We conclude that the reinstated non-qualified restricted shares and stock option units Petitioner received for
signing the non-competition agreement with Merrill Lynch are not subject to New York income tax.
Facts
Petitioner was a resident of Connecticut and an employee of Merrill Lynch in its New York City office until
March 31, 2005. Petitioner submitted his resignation from Merrill Lynch on January 26, 2005. He received nonqualified restricted shares and stock option units (hereinafter RSU) in February 2004 and 2005 related to his
performance for the preceding year. The RSU agreements, however, provided that all outstanding RSUs would expire
and be forfeited on a date 30 days following the date of the employee’s termination unless the employee was given
reduction in staff status. Following the submission of his resignation, Petitioner was approached by Merrill Lynch and
asked to: (1) assist Merrill Lynch in the retaining and transitioning of his primary clients; (2) continue to work for
Merrill Lynch until March 31, 2005; and (3) sign a non-competition agreement which, for a period of three years,
prohibited Petitioner from working at a recognized investment bank. The terms of the non-competition agreement
state that, in return for signing and complying with the agreement, Merrill Lynch would reinstate his forfeited RSUs,
and his resignation was given a reduction in staff status which allowed the RSUs to vest. The non-competition
agreement does not include any provisions concerning compensation for Petitioner’s other post resignation activities
on behalf of Merrill Lynch. Petitioner, for his post resignation activities, continued to receive his regular salary, which
he reported on his 2005 New York nonresident return.
Analysis
A nonresident is subject to New York personal income tax on the net amount of items of income, gain, loss,
and deduction included in the nonresident’s federal adjusted gross income that are derived from or connected with
New York sources. (Tax Law §631(a)). Items of income, gain, loss, and deduction derived from or connected with
New York sources include those items that are either attributable to a business, trade, profession or occupation carried
on in New York or income from intangible personal property, but only to the extent that such income is from property
that is employed in a business, trade, profession or occupation carried on in New York. (Tax Law §§631(b)(1)(B) and
631(b)(2)). Therefore, had Petitioner remained employed with Merrill Lynch or if his voluntary termination of
employment with Merrill Lynch had not caused the forfeiture of the unvested RSUs (pursuant to the RSU agreement),
the RSUs would have been subject to New York income tax when they vested and/or were exercised.
Income received by a nonresident as consideration for entering into a non-competition agreement is not
considered to be an item of income, gain, loss or deduction that is either attributable to a business, trade, profession, or
occupation carried on in New York or income from intangible personal property, that is employed in a business, trade,
profession or occupation carried on in New York. In Matter of Colitti (Tax Appeals Tribunal, June 19, 2003), the Tax
Appeals Tribunal found that the payment a nonresident received for signing a non-competition agreement was ordinary
income to him but noted that “[t]he payment was made to petitioner for the observance of the covenant not to
perform competing services without geographic restriction. Therefore, the taxpayer could only comply with the terms
of the contract and be entitled to compensation pursuant to the agreement by refraining from performing services in

TSB-A-09(2)I
Income Tax
February 9, 2009

-2-

New York and elsewhere.” In its conclusion, the Tribunal stated that “[i]f New York can tax petitioner because he
might have performed services in New York but for the covenant, the petitioner is being taxed on a business, trade,
profession or occupation not carried on in New York; clearly, a situation not embraced by Tax Law §631(b)(1)(B).”
Thus, Petitioner, a New York nonresident, is not subject to New York income tax from the exercise of his reinstated
RSUs, because the reinstatement of the RSUs was in consideration for entering into the non-competition agreement
with Merrill Lynch and does not fall within one of the categories enumerated in either Tax Law §§631(b)(1)(B) or
631(b)(2).

DATED: February 9, 2009

NOTE:

/S/
Jonathan Pessen
Director of Advisory Opinions
Office of Counsel

An Advisory Opinion is issued at the request of a person or entity. It is limited to the
facts set forth therein and is binding on the Department only with respect to the person
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describes all relevant facts. An Advisory Opinion is based on the law, regulations, and
Department policies in effect as of the date the Opinion is issued or for the specific
time period at issue in the Opinion.